It’s not easy to admit that your business is in financial trouble. When all else fails, it’s time to consider filing for bankruptcy. While this step might seem scary, you’re not alone — 18,926 businesses filed for bankruptcy in 2023.
There are several different types of bankruptcy a business can declare in the United States. Some require you to close down your business, while others allow your business to keep operating and regain financial stability over time. Whichever kind of bankruptcy you choose, the legal procedure can give your business some relief from creditors.
However, the goal of bankruptcy isn’t just to protect the business owners. This process also has provisions to protect employees, vendors, and creditors.
Bankruptcy can ease some of your debt burden, but your business will likely still need to pay some of its debts in the years following the bankruptcy. Your business will also have more difficulty getting loans in the future.
Bankruptcy Law Qualifications for Businesses
There are three types of bankruptcies for businesses under the U.S. Bankruptcy Code. There are different requirements to qualify for each type of bankruptcy.
Chapter 11 Bankruptcy
Chapter 11 bankruptcy, or “reorganization bankruptcy,” is a common choice for medium to large businesses that have a realistic chance of getting back on track. It lets your business restructure its finances and operations without shutting down.
This type of bankruptcy also protects your business from most collection actions from creditors during the formal bankruptcy process. It forces your creditors to negotiate payment plans with you. You may even have some of your debts discharged, but you will likely need to pay back most or all of your debts over five to ten years.
Chapter 11 bankruptcy requires you to create a plan for paying back your debt in a certain order and to pay for a court-appointed creditors’ committee. Your plan may include proposals to renegotiate leases and contracts, reduce debt (often by repaying it using business assets), and restructure operations to become more profitable. The creditors’ committee can put forth a competing reorganization plan. Both your creditors and the court must approve the final reorganization plan.
To be eligible for a Chapter 11 bankruptcy, you need either significant assets or a viable plan to restructure your business’s debt and operations. You will need to disclose a lot of financial information to the court. You must also be able to pay all bankruptcy administrative expenses when the plan goes into effect.
Chapter 11 Subchapter 5 Bankruptcy
Subchapter 5 was introduced in 2020 as a resource for small to medium businesses. This form of bankruptcy is faster, less expensive, less legally complex, eliminates personal disclosure, and lets business owners keep their equity and primary control.
You can use the bankruptcy process to challenge or break UCC liens and reduce or shed unsecured debt. You can also create a payment plan for your bankruptcy administrative expenses.
Like standard Chapter 11 bankruptcy, Chapter 11 Subchapter 5 bankruptcy lets your business reorganize its debt, shed some of its unsecured debt, and avoid shutting down. You must create a plan to pay off the remaining debt over 3-5 years and pay your unsecured creditors with your disposable income while the plan is in place. However, you don’t need to get approval from creditors for your plan, just the court. Your business will get the same legal protections as in standard Chapter 11 bankruptcy.
To be eligible for Chapter 11 Subsection 5 bankruptcy, your business must have debt under $3,024,725 as of August 2024.
Chapter 7 Bankruptcy
Chapter 7 bankruptcy, AKA liquidation, is an option for businesses that don’t show potential to survive. It often happens when a business has debts that can no longer be restructured. In many cases, the business lacks the assets to even begin the bankruptcy process.
In this type of bankruptcy, the court appoints a trustee to convert the company assets into cash. For instance, if your business is a restaurant, the trustee will sell any catering vans, kitchen equipment, and furniture. The money from these sales is then distributed to the creditors in a certain order: secured creditors first, then low-risk creditors such as bondholders, and then higher-risk creditors such as stockholders if there is anything left.
Don’t assume you’re done with your creditors after filing, though. It’s easy for a creditor to file an adversary proceeding in an attempt to collect, which may mean an expensive lawsuit.
If you are a sole proprietor, your personal assets are not separate from your business assets. This means the trustee can sell some of your personal assets, and your credit score will be affected. General partners and limited partners who signed guarantees can also be liable for business debts.
In Washington State, there are bankruptcy exemptions for home equity up to a certain amount, a modest car, a small amount of cash, certain amounts of household goods, professionally prescribed health aids, most tax-exempt retirement accounts, and up to $15,000 worth of tools of your trade, among other things. You may be discharged of remaining liability on the debts.
Corporation owners and limited partners are typically not personally liable for business debts. The corporation or partnership itself will still have liability, which means it can’t continue to operate. Keep in mind that creditors can collect against a new business if a court decides that it is an extension of the closed, bankrupted business.
Chapter 12 Bankruptcy
Chapter 12 bankruptcy is designed for small farms and fisheries. It lets owners restructure their business finances without losing ownership of their assets.
The business has 90 days to create a payment plan for the next 3-5 years while working with creditors and a court-appointed trustee. Your plan may have specific debt levels to repay that change depending on commodity prices and the economy.
Only farms and fisheries are eligible for this type of bankruptcy. If you choose this option, you can expect court-supervised meetings with creditors and an automatic stay provision for consumer debt that keeps your creditors from collecting.
What Happens After Filing For Bankruptcy?
If your business files for Chapter 7 bankruptcy, you must stop all operations. You will go completely out of business, and a trustee appointed by the court will sell all of the company’s assets.
There’s nothing that legally prevents the business owner from starting a new business with a different name in the same industry. However, creditors can collect against that business if a court declares it is an extension of the bankrupted business.
If you file for a Chapter 11 or 12 bankruptcy, you will need to submit a restructuring plan alongside a lot of financial documents. These include your assets, liabilities, expenditures, contracts, leases, balance sheets, and reports showing profits and regular earnings. Your plan must describe how you will repay your creditor, make payroll, and meet tax obligations.
Once the creditors and the court have approved a restructuring plan, you can implement it. You can then sell off assets, renegotiate or void contracts that show a potential loss, and pay creditors with the profits you generate.
How to File For Bankruptcy
To file for bankruptcy, you will need to submit several documents to your local bankruptcy court:
- A voluntary petition for bankruptcy.
- Schedules listing your business’s property, debts, income expenditures, contracts, and unexpired leases.
- A statement of financial affairs.
- A list of the names and addresses of all creditors, the amount and nature of their claims, and anyone else who should receive notices from the court in the case.
Depending on the type of business you have and the type of bankruptcy you are filing for, you may need to submit additional documents. It’s a good idea to speak with a lawyer about what you need to do in your specific situation.
While it may seem counterintuitive, filing for bankruptcy comes with fees. You can expect to pay a filing fee and then additional administrative fees depending on the type of bankruptcy you choose. For instance, if you file for Chapter 11 bankruptcy, you will need to pay for the court-appointed creditors committee.
Bankruptcy Law FAQs
Can a business still operate after bankruptcy?
In many cases, your business can keep operating after filing for bankruptcy and after the discharge. It depends on the type of bankruptcy you declare.
If you choose a Chapter 11, Chapter 11 Subchapter 5, or Chapter 12 bankruptcy, you will be able to continue operations. However, businesses that file for Chapter 7 bankruptcy must stop operations.
Bankruptcy may give you the opportunity to discharge some of your debts and modify contracts so you can become a more efficient operation. If you hope to keep your business running, we recommend speaking with a business lawyer about your options.
If you don’t see a way to make your current business profitable through reorganization, then you can file for Chapter 7 bankruptcy and let the business end. You can start a new business afterward as long as the court doesn’t declare it an extension of the old business.
How does bankruptcy affect a business owner?
Bankruptcy can affect business owners in different ways depending on the business owner and the type of bankruptcy they file for.
If you file for Chapter 7 bankruptcy, your business will be shut down. All business assets will be sold to pay off debts. Sole proprietors will be liable for the debt and see an impact on their credit score from the bankruptcy. General partners and other partners who have signed guarantees may also be liable for some or all of the remaining debts. However, limited partners and corporation orders typically don’t see an effect on their credit reports.
If you file for a Chapter 11 bankruptcy, you can keep your business open. However, your business will need to make a plan to pay back some or all of its debts over the next few years. With a standard Chapter 11 bankruptcy, you must get a plan approved by both creditors and the court. With a Chapter 11, Subchapter 5 bankruptcy, you will only need to get the plan approved by the court.
Can a small business survive bankruptcy?
Yes, small businesses can survive bankruptcy in some cases. If you choose a Chapter 11 or Chapter 11 Subchapter 5 bankruptcy, your business can stay in operation. However, you will need to pay back some or all of your business debt based on a plan approved by the court.
What is the most common type of bankruptcy for businesses?
The most common type of business bankruptcy is Chapter 7, which liquidates business assets. However, reorganization bankruptcy under Chapter 11 is also common for businesses.
Should I talk to a lawyer about bankruptcy laws?
While you are not legally required to have a lawyer during the bankruptcy process, it’s always a good choice. If you can’t afford a business lawyer, you may be able to use a free or low-cost legal service.
A lawyer can advise you about questions such as:
- Whether it makes sense to file for bankruptcy.
- Which type of bankruptcy you should file for.
- What to expect during the bankruptcy process.
- How to meet all the legal requirements, including which forms you need to file.
- What kinds of debts can be eliminated or reduced.
- Whether you are personally liable for the business debt and what personal property you can keep.
The right lawyer can represent you in court, take care of legal matters for you, help keep your paperwork on track, and help you through any business litigation procedures. They can also deal with debt collectors for you. If you tell a debt collector that you are represented by a lawyer, the collector is supposed to communicate with the lawyer instead of you.
If your business needs legal advice in Western Washington, the Anderson Hunter Law Firm can help. Schedule a consultation with a business lawyer to learn more about how filing for bankruptcy could affect your business.